Improving the Framework of Credit Bureaus’ Operations: Key … · Here, we identify the main problems in credit bureaus’ operations in the country, and provide policy recommendations

Final Report

Improving the Framework of Credit Bureaus’ Operations:

Key Recommendations

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Consultant:

BE Berlin Economics GmbH

Schillerstr. 59

10627 Berlin

Germany

Tel: +49 30 206 134 640

Fax: +49 30 206 134 649

[email protected]

Date of submission: 30 May 2012

This report has been financed by the Federal Ministry of Finance of Germany through KfW

Entwicklungsbank under the TRANSFORM programme and its successor.

© 2012 BE Berlin Economics GmbH. All rights reserved.

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Executive Summary

Credit bureaus are an essential part of the financial infrastructure of a country. By pooling

and exchanging information about borrowers, banks can improve their risk management and

lending decisions. In such a way, the cost of borrowing can be reduced and the access to

finance of previously underserved borrowers like SMEs increased, a fact that is supported by

wide empirical evidence. Consequently, credit bureaus are not just important for banks, but

also for the real economy and the society.

Ukraine has several credit bureaus, but the sector as a whole is not working properly yet. In

this report we identify the main causes for this and put forward recommendations to

improve the situation. One major problem relates to the regulation and supervision of credit

bureaus, which lies in the responsibility of the National Commission for Regulation of

Financial Services Market. Unfortunately, the commission lacks the necessary institutional

capacities for this task, with negative implications for the sector. Consequently, we

recommend shifting this important task to the National Bank of Ukraine (NBU), which has a

wide knowledge about the banking sector due to its role as banking supervisor. Ukraine’s

credit bureau sector should be based on private bureaus, and within a strong regulatory and

supervisory framework guaranteed by competent state authorities. This is our vision of the

future.

A further key problem relates to the sources of data for credit bureaus. In many cases, banks

either do not report credit information at all, or they restrict their reporting to “black”

information. Furthermore, the access of credit bureaus to public registries is far from optimal,

especially to those under the Ministry of Justice. Last, data at the level of individual credit

bureaus is highly fragmented, in part due to a lack of cooperation between credit bureaus. In

principle, there are two ways for the banking regulator to try to improve the situation:

mandatory schemes or regulatory incentives. For example, the regulator can mandate that

information has to be delivered to credit bureaus or it can increase the level of required

reserves for loans, for which no information has been sent to credit bureaus. Based on

international experience and taking into account Ukrainian reality, we recommend to base

policy on incentives rather than on mandatory schemes.

Also the issue of data protection is crucial. Here it is essential to strike a balance between the

objectives of efficient information sharing and of ensuring and protecting the informational

privacy of individuals. Besides, if individuals do not trust the system, then it is highly

unlikely that the system will work properly.

Improving the framework for credit bureaus is thus a joint task for all stakeholders in the

public and private sector, with clearly defined roles and responsibilities. This will contribute

to a more stable banking sector, but it will also improve the access to finance of SMEs and

individuals, thus contributing to the growth of the banking sector. Consequently,

implementing the recommended measures will lead to more stability while ensuring

sustainable growth, two aspects which often are not easy to combine. Therefore, progress in

this important field is exactly what the banking sector in Ukraine needs after the massive

shock during the international financial crisis in 2008/2009.

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Contents

1. Introduction ..................................................................................................... 5

2. Economic Functions of Credit Bureaus ...................................................... 6

2.1. Definition and Concepts ................................................................................................ 6

2.2. Economic Advantages ................................................................................................... 6

2.3. Specific Issues in Emerging Markets ........................................................................... 7

2.4. Empirical Evidence......................................................................................................... 7

2.5. Credit Bureaus in Ukraine: The Road Ahead ............................................................. 9

3. The Fundamental Role of the State in Information Sharing ............... 10

3.1. Regulation and Supervision .........................................................................................10

3.2. Market Structure: Private Credit Bureaus vs. Public Credit Register ....................11

4. Improving Data Submission and Information Exchange ..................... 14

4.1. Banks and Credit Bureaus ............................................................................................14

4.2. Access to State Databases and Public Records ..........................................................16

4.3. Inclusion of Information Delivered by other Institutions ........................................18

4.4. Preventing Data Fragmentation ..................................................................................19

5. Consumer Protection Issues ....................................................................... 20

5.1. Privacy Data Protection ................................................................................................20

5.2. Credit Collection Agencies ...........................................................................................21

References ................................................................................................................ 23

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List of Figures and Tables

Figure 1: Countries with Private Credit Bureaus (left) and Public Credit Registries (right) ..... 8

Table 1: Voluntary versus required sharing of credit data: European Experience ....................14

Table 2: Sources of personal data: European Experience (Survey of 30 bureaus) ......................16

Table 3: Access to Public Databases and Registries ........................................................................17

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1. Introduction

Ukraine’s economy, and in particular its financial sector have been hit exceptionally hard by

the global financial crisis in 2008/09. The country has so far not fully recovered from the

output losses during the crisis, when real GDP posted a record 15% decline in 2009. The

banking sector suffered equally hard during the crisis, with massive liquidity and solvency

problems at a number of institutions. The state, supported by the international donor

community had to bail-out a number of systemic institutions during that process in order to

prevent an outright collapse of the system.

In line with recent trends and developments in the real economy, a post-crisis recovery in the

financial sector in Ukraine is currently observable. Even though this process is still fragile,

and subject to many external and internal risk factors, it signals that the worst is likely over.

At the same time, the current recovery phase gives the opportunity to focus on drawing

important long-term lessons from the crisis. While the last crisis was mainly caused by

negative external shocks, existing structural problems in the banking sector made Ukraine

vulnerable and exuberated its negative impacts on its economy.

The overall objective for all stakeholders concerned (regulator, banks, clients) must be to

make bank lending in Ukraine a more reliable process than previously, which strikes the

right balance between the sector’s growth and stability1. Among the many structural and

institutional reform aspects that are of interest here, a key component is a fully functioning

credit reporting system. The main purpose of credit bureaus is to stimulate comprehensive

information collection and sharing, in order to help lenders make better decisions. Credit

bureaus are thus an essential part of the general credit infrastructure; if they do not function

properly, access to finance is often constrained, i.e. severe financial constraints hinder

otherwise creditworthy firms and individuals from obtaining much-needed finance. This is a

problem especially for small and medium sized companies (SMEs), which are an important

factor for economic growth and job creation. The economic benefits of credit bureaus thus

extent far beyond the direct benefits for banks. The associated positive impact on Ukraine’s

economy and society is even more important, potentially creating a win-win situation among

lenders, borrowers, and society as a whole.

This paper contributes to the ongoing discussion on improving the credit bureau system in

Ukraine. It is structured as follows: In chapter two, we show the important economic

functions of credit bureaus. There is wide empirical evidence that such bureaus can facilitate

access to credit as they help lenders make better decisions. The remaining chapters three to

five are devoted to the concrete situation in Ukraine. Here, we identify the main problems in

credit bureaus’ operations in the country, and provide policy recommendations on how to

improve them.

1 For a detailed analysis of Ukraine’s banking sector and some policy recommendations, see Kirchner et

al. (2011).

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2. Economic Functions of Credit Bureaus

2.1. Definition and Concepts

Each borrower in financial markets leaves a trail of important information behind his

transactions. This concerns e.g. his past payment behavior, including the full and timely

payment of existing financial obligations, but also the sum of all loans taken from different

sources as well as information stored in public databases. Credit bureaus collect, process,

maintain and analyse this information from a variety of sources, and make it available upon

request to their subscribers in different forms, among them banks and non-bank financial

institutions as well as supervisory authorities. In this process, they reduce information

asymmetries, and allow lenders to more accurately assess credit risks and thus improve the

quality of their portfolios. Credit bureaus can thus be seen as a driving force in information

transfer and exchange, which increases transparency and can be considered as an important

element of modern banking. Financial markets around the globe increasingly understand the

value of sharing data.

Information for both individuals and entrepreneurs (consumers and retail loans, as well as

mortgages) and corporate entities (mainly SMEs) are usually collected by credit bureaus.

While lenders rely usually on other mechanisms to assess the creditworthiness of bigger

firms and corporations, their options regarding individuals and SMEs are much more

limited. The absence of comprehensive and reliable information on these groups implies that

the lending risk for banks is exceptionally high, resulting in a constrained access to finance

for “good borrowers” among these groups.

2.2. Economic Advantages

Economic theory suggests a number of important economic benefits from the existence of a

system of fully operational credit bureaus. The four key advantages of sharing information

are the following2:

1. Better assessment of default risk: The information supplied by bureaus in their credit

reports/histories helps lender to assess the default risk/creditworthiness of the borrower

much better. This eases adverse selection problems; banks can target and price loans

much better, concentrate their marketing efforts on “good” clients, including developing

new products for them.

2. Reduction of informational rents: By reducing the informational rents that a bank could

possibly extract from a certain borrower, information pooling by bureaus leads to a more

competitive loan pricing.

3. Enforcement of borrower discipline: Since each borrower knows that his reputation

with all potential lenders is negatively affected if he defaults, this reduces moral hazard

effects.

2 See Japelli/Pagano (2000) for a more detailed discussion.

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4. Elimination of incentives to overborrow: Since a well-organised system discloses the

overall indebtness of a borrower, this eliminates incentives to overborrow from multiple

lenders.

In practice, the advantages of credit bureaus discussed above create a win-win situation for

all participants, namely:

1. Lenders (banks): Better lending decisions and risk management at individual banks lead

to a better performance at the individual bank level, with lower losses from defaulted

loans.

2. Borrowers (individuals, SMEs): The mentioned decline in loss rates will also benefit

“good” clients, which enjoy better access to credits and lower interest rates as a result.

3. The financial sector: A more sustainable lending process strengthens the financial and

banking sector, bolsters confidence and supports the recovery of the financial system

after the crisis.

4. The national economy, or more general, society: Important socio-economic effects are

associated with a strengthened banking sector and improved credit allocation. This

directly increases economic stability, leads to higher economic growth and a more

dynamic economy.

2.3. Specific Issues in Emerging Markets

In the context of emerging markets and economies in transition, there are additional

economic arguments for the activities of credit bureaus. Such countries are often

characterized by a weak protection of creditor rights (e.g. in terms of enforcing repayment,

getting access to collateral or taking control of the defaulted company) as well as having a

lower (accounting) transparency.

These specific features increase screening costs for banks and aggravate information

asymmetries, in particular for loans to individuals and SMEs. Often, the loan volumes in

question do not justify a targeted credit risk analysis, which would be rather expensive.

Against this background, the information sharing process associated with credit bureaus is

even more valuable than in developed markets, as it at least partially substitutes for weak

creditor protection through the legal system.

An additional argument for credit bureaus in emerging markets is that they can also facilitate

the transition from a mainly collateral-based lending system to a modern cash-flow

(information-) based system.

2.4. Empirical Evidence

The number of countries which established credit reporting systems, either in private (i.e.

credit bureaus) or public (credit registry) ownership3 has grown spectacularly over the last 25

years, as the following figure 1 shows.

3 We will return to the question of ownership in the next chapter.

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Figure 1: Countries with Private Credit Bureaus (left) and Public Credit Registries (right)

Source: IFC (2006)

Note: Please note the different axis dimensions on the left and the right side figure.

Parallel to this explosive growth, there is a wide and growing empirical literature on the

effects of information sharing in banking in general, and the activities of credit bureaus in

particular. This literature usually tries to identify links between the operations of credit

bureaus on credit penetration, credit growth (access to credit), default rates (NPLs), and

interest rates, often distinguishing between different borrower categories (individuals,

SMEs). Both developed and emerging markets are the subject of the literature. We try to give

a short overview of the main results that can be taken from this growing literature below.

Impact on credit penetration:

Japelli/Pagano (1999) are among the first pioneers in the economic literature to identify a link

between information sharing and the breadth of credit markets in a cross-country study.

Bank lending to the private sector (measured in relation to the gross national product) is

higher in countries where more active information sharing is practiced. Credit sharing is thus

an important determinant for credit availability. These results are supported by Djankov et a.

(2005), which analysed a sample of 129 countries. The introduction of private or public

information sharing (in form of credit bureaus or a public credit registry) raised the private

credit to GDP ratio in a statistically significant and quantitatively important manner.

Specifically, after the introduction of information sharing mechanisms, the private-credit-to-

GDP ratio increases by 7 - 8 percentage points over a 5 year horizon. Equally important, the

more comprehensive the information is that is distributed, the higher the impact; a finding

that is also reported by other authors.

Impact on interest rates and defaults:

The previously mentioned study by Japelli/Pagano (1999) also found that information

sharing leads to lower loan delinquencies and defaults and helps to decrease interest rates for

borrowers. Turner et al. (2008) reported similar results of lower losses and lower interest

rates.

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A joint Inter-American Development Bank/World Bank survey in 2002, covering banks in

Latin America that lent primarily to consumers and SMEs, found that using information

sharing mechanisms lowered the rate of non-performance in their loan portfolios as

compared to banks which did not use information sharing.

Impact on particular borrower groups:

The impact of information sharing on different borrower groups is another focus of the

empirical literature. Love/Mylenko (2003) analysed a sample of 5,000 firms in 51 countries

and found that the introduction of information sharing mechanisms caused the share of

SMEs reporting financing constraints to drop from 49% to 27%. The probability of granting a

loan to SMEs increased from 28 to 40%.

Turner/Vargese (2007) and Turner et al. (2008) found that an increase in the coverage of

credit bureaus helps especially previously financially underserved groups of the population.

As a result, the associated increase in lending leads to a more equal income distribution.

Impact on emerging markets:

Brown et al. (2009) analysed a sample of 5,717 firms in 24 transition countries and confirmed

that information sharing leads to better access to credits and lower costs of borrowing.

Smaller firms profited relatively more than bigger ones from these developments.

Information sharing thus seems to be especially important in countries with weaker legal

environments, and thus weaker creditor protection. This result is supported by Djankov et al.

(2005), where improvements in information sharing mechanisms are especially relevant for

lending in less developed countries. This effect could not be replicated in developed markets,

where other determinants seem more important in explaining lending.

2.5. Credit Bureaus in Ukraine: The Road Ahead

From extensive talks with different stakeholders4 the general conclusion can be drawn that

the current system of information sharing in Ukraine is not working properly, as many

problems are being reported5. Thus, the important functions of a credit reporting system are

not being fulfilled from an economic and social point of view. This is not surprising, taking

into account the still relatively new concept, and the economic transition context. Indeed,

similar problems are reported from other emerging markets and transition countries, where

different stakeholders resist the concept of information sharing due to different reasons.

In the following chapters, we identify areas where problems were frequently reported, and

provide recommendations on how to improve the situation. This relates to the fundamental

4 This concerns banks, credit bureaus, the regulator, the National Bank, non-bank financial institutions and international financial institutions, among others.

5 In order to assess the performance of credit bureaus in Ukraine, we rely mainly on the results of our

frequent conversations with all relevant stakeholders. It is extremely difficult to measure the performance of the bureaus with objective indicators only, as ideally a wide number of both qualitative and quantitative factors need to be taken into account, for which often no information are publicly available.

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role of the state in the credit reporting landscape (chapter 3), to data issues (chapter 4) as well

as ensuring a high degree of consumer protection (chapter 5). Even though the international

credit reporting landscape is extremely diverse and complex, certain international best

practices can offer some important insights in this respect.

3. The Fundamental Role of the State in Information Sharing

3.1. Regulation and Supervision

Until 2009, credit bureaus in Ukraine were licensed, regulated and supervised by the

Ministry of Justice. On 4 March 2009, with the passing of the Law “On the Introduction of

Changes to the Law “On the Organization of the Formation and Circulation of Credit

Histories””, the Ukrainian Parliament transferred the functions of licensing, regulation and

supervision of the activities of credit bureaus to the State Commission for Regulation of

Financial Services Markets. The commission was liquidated in 2011 by Presidential Decree

#1069 and at the same time Presidential Decree #1070 established the National Commission

for Regulation of Financial Services Market. The commission fulfils the same tasks as before,

but is now subordinated to the President, not the Cabinet of Ministers, as the predecessor6.

The associated reorganisation will take time, some sources indication a timeframe of up to

one year.

There is wide agreement among stakeholders that the current licensing, regulation and

supervision framework is weak for several reasons, and has contributed to the low

performance of credit bureaus active in Ukraine. Limited institutional capacity in the

commission, which is currently in the process or reorganization, is the most frequent reason

quoted. This has led as a result to a situation where serious questions regarding data

security, integrity and transparency have arisen, with negative implications for the credibility

and trust of the whole system. Specifically, among currently licensed bureaus there seem to

be a number of institutions that cannot be considered “standard” bureaus, which collect their

data from doubtful sources, and thus discredit the whole sector. The problems observable in

private credit bureaus operations in Ukraine seem to us more rooted in these deficiencies in

licensing and supervision, i.e. in regulatory failure, rather than in a market failure.

In many countries, a data protection authority is responsible for the oversight over credit

bureaus. However, the data protection service in Ukraine is still in its infancy and it is

struggling to fulfil its core responsibilities that include registration of databases with

personal data7. Thus, the most sensible solution would be to task the National Bank of

Ukraine, which oversees the banking sector, with the oversight of credit bureaus. This

institution, which has a wide experience and professional and qualified staff, would be the

natural choice for such a change towards strong regulation and supervision.

6 This was already done in 2010, when the subordination to the Cabinet of Ministers (a result of

constitutional changes in 2004) was declared invalid.

7More information on this can be found in chapter 5.1.

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It goes without saying that licences should only be awarded to qualified credit bureaus

which meet the highest international standards in terms of information sharing. Turner et al.

(2009) list a number of areas which are of crucial importance for a credible system:

• Data quality

• Data security

• Transparency

• Data integrity

• Consumer dispute resolution

In addition to these objectives, which the regulator should keep in mind in its work, there are

many more that have been extensively discussed in this report: Prevent data fragmentation,

and ensure full and comprehensive reporting. All this needs to be implemented in a

competition-neutral way, which does not create distortions and does not favour particular

institutions. To ensure a level playing field on which a number of private institutions

compete on price, data quality and other value-added services would be optimal from an

economic and social point of view.

Recommendation 1: Regulatory failure, rather than market failure is the key reason for the

relatively low performance of credit reporting so far. A fundamental shift in the licensing,

regulation and supervision framework is thus needed, as the current approach failed to a

large extent. The National Bank of Ukraine should take over regulation and supervision

and ensure a level playing field for private bureaus.

3.2. Market Structure: Private Credit Bureaus vs. Public Credit Register

In credit reporting systems, two major types of institutions can be normally distinguished:

Private credit bureaus and public credit registries. In the following, we will analyse both

institutions in more detail.

Private credit bureau (PCB)

Private credit bureaus are voluntary data exchange institutions, which compete with each

other in the credit information business. Most bureaus operate for profit, but also some non-

profit bureaus can be found. In Europe, a recent industry survey found that 83% of the

European credit bureaus work for profit (Rothemund/Gerhardt, 2011). In general, two forms

can be distinguished further: Bureaus owned by banks or bank associations (“non-neutral”),

and bureaus not affiliated with banks (“neutral”). While bank-owned bureaus are usually an

important starting point to establish a private credit bureau system, such bureaus may not be

optimal for reasons related to competition, not just in data exchange, but also in the banking

market8.

8 This is an issue observed in a number of countries, where bank-owned bureaus impeded access to

information sharing, with negative implications for banking competition.

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The dominant profit-orientation of private credit bureaus has two important implications.

First, they tend to collect credit information as comprehensive and detailed as possible, in

order to deliver as much information as possible to their clients (usually, but not exclusively

banks). This is particularly true for information on consumer and SME loans, which are

usually ignored by public credit registries due to their small quantitative sizes. Also, the data

sources that deliver information to credit bureaus are not limited to banks, but can include

also non-bank financial institutions (e.g. leasing and microfinance institutions), as well as

non-financial companies like telecoms and utilities. A second important implication is that

private bureaus that compete fiercely for business are constantly in the process of

introducing new products and services to their clients, as well as to improve their cost

efficiency, in order to stay ahead of competition. The development of new products and

services (e.g. credit scoring, consulting services, portfolio monitoring, fraud detection, etc.) is

a permanent objective for such institutions.

In Ukraine, credit bureaus are still relatively new institutions in the financial infrastructure of

the country. After a comprehensive legal framework for their operations was established in

2005, the first bureaus received their licenses in 2007. Currently, there are 7 credit bureaus

operating in Ukraine9, even though not all licensed bureaus can be considered “standard”

bureaus that operate according to international best practice10. Despite the shortcomings

mentioned above in terms of operational performance, there is some empirical evidence that

information sharing through private credit bureaus led to an increase in bank lending in

Ukraine in the past. Furthermore, the more credit bureaus a bank collaborates with, the

higher is the volume of credit expansion. A bank-level study by Grajzl/Laptieva (2011)

reports such findings, which are robust through a variety of different specifications and

estimation techniques.

Public credit registry (PCR)

A public credit registry is a database created by public authorities and usually managed by

the central bank (bank supervisor). It contains credit information, which is compulsory

delivered by certain financial institutions, and which get access to this database in return.

Usually, there is wide banking data coverage (i.e. all institutions regulated by central bank),

but information from other institutions (non-bank financial institutions, telecoms, utilities,

etc.) is not included. The purpose of public credit registries is mainly defined by bank

regulation and supervision motives, and by ensuring financial stability. Therefore, in most

cases there is a threshold size for loan reporting, which excludes smaller loans to individuals

and SMEs.

In Ukraine, a „Common Information System” listing delinquent borrowers exists since

October 2001, and is operated by the banking supervision department of the National Bank

of Ukraine. While participation is officially voluntarily (although recommended), most banks

report their credit information. The loan threshold size is UAH 10,000. However, in terms of

usage a number of banks remarked that the system is in its current form not user friendly,

9 For an overview, see Kirchner et al. (2010).

10 We will analyses this issue in more detail in the following chapters.

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and thus has a relatively small benefit for their operations11. It provides no real online access

(only email), and there are no clear and transparent database update rules. The low interest

from the side of banks is matched by the low interest from the side of the National Bank to

improve the system. It is therefore not a surprise that the empirical literature fails to identify

an effect of information sharing through the public credit registry on bank credit extension in

Ukraine. Grajzl/Laptieva (2011) reported that no statistically significant effects could be

found in their analysis.

PCBs versus PCRs: Implications for Ukraine

In Ukraine, there is an on-going discussion about the “right” market structure of the credit

reporting system. Several stakeholders point out that private bureaus have failed to fulfil

their functions, and thus propose a stronger involvement of the state in the market, possibly

building on the existing public registry. We remain sceptical of such an approach, as in our

view the main fault of the current system has been inadequate regulation, rather than a

wrong market structure. The problematic and somewhat disappointing performance of the

public registry is another argument in support of our view.

Internationally, the market structure in credit reporting systems regarding private credit

bureaus and public credit registries is rather fragmented. While there are a few countries that

rely only on private bureaus (e.g. the US, the UK and Canada, among others), and a few

other countries that have only a public registry (e.g. France), most countries have a mixed

market structure that includes both private bureaus and a public registry, with very different

degrees in terms of practical implementation and coverage. A strong determinant for the

emergence of a predominantly private or public system seems to be the legal system of the

country, i.e. if it is based on English common law versus French civil law.

Taking into account the many differences between private credit bureaus and public credit

registries, it is obvious that they are not mutually exclusive, but rather complementary in

nature. Indeed, many possibilities of interaction exist, which help to improve the credit

reporting system in general. In some countries, PCRs were created to stimulate competition

with (non-neutral) PCBs, which were sometimes perceived to be too close to existing banks,

and which resulted in a difficult entry for new banks in the banking market. In other

countries, PCRs deliver their data also to PCBs, which make use of this information in their

credit reports.

Recommendation 2: A public credit registry should not be seen as a substitute for private

credit bureaus, but rather as an important complement, which opens new ways of

interaction. Private bureaus must remain the main pillar of the credit reporting system in

Ukraine.

11 See also Grajzl/Laptieva (2011) on this.

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4. Improving Data Submission and Information Exchange

4.1. Banks and Credit Bureaus

The more information credit bureaus can collect from banks, their main source of data, the

more complete are the credit histories of the data subjects they contain in their database. This

provides for the most accurate assessment of credit risks and leads to better lending

decisions.

Contrary to these obvious benefits in terms of full-fledged and comprehensive information

sharing, in practice two main problems exist. First, banks often do not submit data to credit

bureaus, with negative implications for their databases. Second, in some cases when banks

do report information, they send only negative (“black”) information on defaults and arrears,

while skipping positive information on regular debt service for fear of losing good clients.

These problems have sparked in many countries around the world a lively discussion on the

optimal procedures of data submission. In response to the first problem, the question of

mandatory data submission (to at least one or all bureaus) versus voluntarily data

submission is a central issue in many countries. The following table 1 shows the existing

national differences in data submission in Europe.

Table 1: Voluntary versus required sharing of credit data: European Experience

Country Is credit data sharing required by national regulation?

YES NO

Austria x

Belgium x

Czech Republic x

Germany x

Denmark x

Finland x

Greece x*

Croatia x

Hungary x

Iceland x

Italy x

Netherlands x

Norway x

Poland x

Romania x

Serbia x

Russia x

Sweden x

Slovenia x

Slovakia x

Spain x

Turkey x

Great Britain x

Total 6 17

Source: Rothemund, M., Gerhardt, M. (2011). The European Credit Information Landscape. An analysis of a survey of credit

bureaus in Europa. Industry Survey. The European Credit Research Institute (ECRI).

Notes: * for bad cheques

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Country experience shows that only in a clear minority of countries data sharing is

mandatory (612 vs. 17). Furthermore, among the 6 mandatory countries, we find also 3

emerging markets (Hungary, Serbia, and Slovenia), where this instrument might have a

temporary character.

But even if data sharing is not mandatory, the banking supervisor can strongly encourage

banks to share information with different incentives. A more favourable regulatory treatment

for loans (in terms of reserve requirements) where such information is submitted to credit

bureaus is an important instrument in this regard. However, it should be noted that in case of

mandatory pressure or regulatory incentives to share data, there might be unintended

consequences. An extreme form of this can be seen in the creation of “captive” bureaus,

where banks – due to legal or regulatory reasons – are encouraged or required to submit data

to at least one bureau, and thus some created their own bureau (e.g. Ukraine, Russia). This

runs clearly against the objectives of encouraging information sharing, and thus should be

prevented as far as possible.

In Ukraine, we favour indeed such an incentive approach over mandatory data sharing. The

relevant instrument is Resolution #23 of the National Bank of Ukraine from 25 January 2012,

which will be effective from the beginning of 2013 and aims to modernise reserve

formation13. This resolution requires banks to classify a company with a loan exposure as at

most risk category 8 (out of 9 categories, with 9 indicating the least creditworthy category)

borrower, if the bank didn’t transmit information to a credit bureau. This has direct

implications for reserve formation. To give a numerical example: Reserve requirements range

between 1% - 6% for a loan to a very creditworthy company (category 1), that is being

serviced timely and the data are transmitted to a credit bureau. For the same constellation,

but with the only difference being that the data are not transmitted to a bureau, the reserve

requirements increase to 7% - 20%. Reserve requirements can increase further in case the loan

becomes overdue (up to 100%). Similar requirements are in force for individual borrowers,

but here only four risk categories exist. If banks do not transmit data to a credit bureau, the

borrower is grouped into the weakest category 4. Reserve requirements are similar to the

case with corporate loans. In addition, banks won’t be allowed to use portfolio treatment for

loans where information is not submitted to a credit bureau, and thus loans must be re-

evaluated every 3 months individually. This is a rather strong argument for submitting data

to credit bureaus, which is available to all loans under UAH 50,000.

The second problem mentioned above relates to the extent of information supplied to

bureaus. Credit risks can be assessed more accurately if the credit history includes both

positive and negative information, i.e. there is full-file reporting. In case mandatory reporting

is required, this should be full-file, i.e. also including positive information. But also the

incentive-related approach to stimulate information sharing must be based on full-file

reporting. A better regulatory treatment of loans can only be granted when banks report all

available information about a client.

12 Actually 5, since in Greece it is mandatory only for bad cheques.

13 Reserve formation is currently governed by Resolution #279, which will expire at end-2012.

16

Recommendation 3: Banks should be encouraged to provide full-file reporting to bureaus.

In this respect, we favour regulatory incentives rather than mandatory data sharing.

4.2. Access to State Databases and Public Records

Apart from information delivered by banks and individuals, there are important additional

information stored in different state databases and public records. This relates e.g. to civil,

commercial, real estate and court registries. Official access by credit bureaus to these data

could improve the credit histories further, and increase the benefit for their users.

This is supported by empirical evidence. A significant number of credit bureaus in Europe

use public records routinely as additional information sources to check the validity and to

extent the information obtained from other sources, as the survey results in table 2 indicate.

Table 2: Sources of personal data: European Experience (Survey of 30 bureaus)

Name Address Date of

birth

Gender ID/

tax ID

Bank-

ruptcy

Court

judgement

Client (Bank) 27 27 23 18 19 5 3

Public Records 11 11 9 8 6 15 13

Individual 4 4 3 3 3 0 0 Source: Rothemund, M., Gerhardt, M. (2011). The European Credit Information Landscape. An analysis of a survey of credit

bureaus in Europa. Industry Survey. The European Credit Research Institute (ECRI).

Note: Above table reports the number of credit bureaus that answered a given question, out of a total of 30 responding bureaus

(multiple answers possible).

While most bureaus obtain the name and address of a particular data subject directly from

the banks (27 out of 30 bureaus), about a third of the European bureaus (11 out of 30) access

also state databases for this kind of information. For other types of data, in particular

registries of companies in bankruptcy proceedings and court judgements, about half of the

bureaus make regularly use of these state databases. The information collected from different

state databases is then used to check the validity and to extent the information obtained from

other sources. Also information from individuals (data subjects) is collected in some cases.

In Ukraine, a problem mentioned by all bureaus, as well as other stakeholders, is the

problematic official access to state databases and public records, which does not work

properly. Especially the access to databases that are administered by the Ministry of Justice is

considered problematic, as no free “real-time” access is possible. Furthermore, some “non-

standard” bureaus apparently use informal data sources, i.e. engage in illegal trade in

personal data, often originating from state databases. The use of data sources which cannot

be verified (=accessed) by consumers is in no way acceptable, as it runs against consumer

data protection motivations and destroys the trust in the whole credit reporting industry.

A more detailed overview of the particular issues in accessing state databases reveals a

mixed picture. Table 3 below lists the relevant public databases and registries and comments

on the current degree of access.

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Table 3: Access to Public Databases and Registries

Database Status/Comment

Database of stolen/lost passports (MIA) Apparently works now after initial

problems

VAT Tax ID (STA)14 Web access

Single registry of companies and

entrepreneurs (Min. of Justice/State registrar

service)

Limited web access

Registry of licenses Web access

Real estate registry, registry of mortgages (real

estate) and liens of movable property (Min. of

Justice /State company “Derzhinformjust”)

Only paid access

Registry of civil acts Available only to relatives and other

interested parties (based on will, life

insurance)

Court judgments/orders (State court

administration)

Court orders are made available online

but names of individuals are anonymised.

Full decisions are available only to people

influenced by the decision.

Bankruptcy/Insolvency registry Paid access Source: Own display

Note: MIA: Ministry of Internal Affairs; STA: State Tax Administration

The Draft Law #10292 recently submitted to Parliament15 requires that all state registries

provide information to credit bureaus in real time. The regulator should facilitate the access

to public databases and serve as a vital information bridge between private bureaus and the

different state sources. At the same time, the fight against the use of informal data sources

must be stepped up from the side of the regulator. This would increase trust and confidence

in the credit reporting industry, and ensure that lending is based only on proper (i.e. formal)

information. This process could be further supported by the credit bureaus themselves. The

development of an industry-wide “Code of Conduct”, in which bureaus pledge to comply

with fair principles in the process of information collection, would be a positive first step.

Recommendation 4: The regulator should facilitate the official access to state databases, a

fact that is critical especially in early stages of market development. In particular, the

Ministry of Justice should grant free “real-time” access of credit bureaus to its databases.

At the same time, it should step up the fight against the illegal trade in personal data and

become more active in prosecuting entities that violate the law. Credit bureaus should

develop a “Code of Conduct” in which they promise to adhere to fair standards in

information gathering.

14 Among credit bureaus in Ukraine, there is an intense discussion on the extent of access to tax

information. Apart from identification purposes, and information on existing tax debt, a further access e.g. on income data etc. seems not in line with international experience.

15 See chapter 4.4 for more information on this.

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4.3. Inclusion of Information Delivered by other Institutions

A broad database including all possibly relevant pieces of information is a key asset for credit

bureaus, and helps banks to adequately assess the credit risks of as many borrowers as

possible. While information supplied by banks and public sources (“segmented reporting”)

are indeed main input factors, non-bank financial institutions (NBFIs) and especially non-

financial institutions offering deferred payments can also deliver important information

(“comprehensive reporting”). Adding such data to credit bureaus’ databases will improve

credit availability especially for previously underserved individuals and SMEs, whose credit

files lacked information that made a correct risk assessment impossible16.

Among NBFIs, credit unions, insurance companies and leasing companies are potential data

suppliers; non-financial data are usually provided by telecoms (mobile, fixed) and utilities

(energy, water). Especially non-financial data providers are of interest, as their services are

more widely used than financial services.

In Ukraine, but also in many other countries, a problem frequently encountered is that

important pieces of information from such sources are not systematically included in the

databases of credit bureaus. Regarding NBFIs, data are partially included. Larger credit

unions based in cities are participating in certain credit bureaus, while rural or small credit

unions are usually not interested. Some insurance companies also supply data and use credit

bureaus. Data from non-financial companies is even scarcer. Retailers, telecoms and utilities

are not among the information suppliers and users.

The reasons why such information suppliers are not being utilised to a fuller extent are

complex. A written consent clause from the individual is needed in any case, but so far not

included in most contracts. The general low level of interest among institutions other than

banks may also be explained by the fact that the advantages of information sharing are not

fully understood outside the financial sector.

In order to improve the situation, both the regulator and the bureaus should promote

voluntary data submission by contributors across industries so that a comprehensive

reporting can be achieved. More marketing efforts from the side of the credit bureaus might

help, especially when the advantages of reciprocity agreements are clearly show to potential

contributors. The focus should be especially on telecoms and retailers, i.e. on the private

sector, as (public) utilities are probably not yet ready for such data sharing. The regulator

should give broad support to these efforts.

Recommendation 5: Comprehensive credit reporting includes also information provided

by non-bank financial institutions, as well as by non-financial firms (telecoms, utilities).

In Ukraine, there is still potential to include such additional data furnishers, a fact that

credit bureaus should address with increased marketing efforts.

16 In this respect, Turner et al. (2006) found empirical evidence that when such “non-traditional” or

“alternative” data suppliers were included, especially low-income individuals as well as minorities with previously no real access to credit benefited disproportionally.

19

4.4. Preventing Data Fragmentation

A problem that is often observed among private credit bureaus competing for business

relates to data fragmentation. This can take the form of a fragmentation across sectors (e.g.

when data providers from different sectors report to different bureaus) or within a sector

(e.g. data providers from the same sector, such as banking) report to different bureaus

(Turner et al. 2009). An extreme form of this data fragmentation can be seen in the existence

of “captive” bureaus, where banks – due to legal or regulatory reasons – are required or

encouraged to submit data to at least one bureau, and thus some created their own bureau

(e.g. Ukraine, Russia).

Data fragmentation observable in Ukraine has clearly a negative impact on the completeness

of credit histories, and thus should be reduced. The more difficult question is how to achieve

this in practice, and what instruments should be used. Should the regulator apply pressure,

or put more emphasis on economic incentives? Or should this process be completely left to

the shareholders of private bureaus in the hope that they might consolidate their assets?

While a single (monopolistic) bureau might appear at first glance ideal in terms of

information pooling, other issues are here more important, especially in a dynamic

perspective. In terms of innovation strength, cost efficiency, service orientation, and other

factors there is no alternative to competition among private bureaus. Indeed, there is no

strong empirical evidence for a natural monopoly in information sharing, so why should

policy makers then push for a monopoly? Recent gains in information technology, which is a

key determinant for the operations of credit bureaus, make this case even less compelling.

Indeed, in many mature markets there is a tendency of an oligopolized market structure,

with a number of private bureaus competing for business.

In Ukraine, two recent initiatives try to improve the still fragmented data landscape:

1) Voluntarily data exchange “One point of access”

This cooperation initiative by the two main bureaus “First All-Ukrainian Bureau of Credit

Histories” and “International Bureau of Credit Histories” was announced in 2011. A major

success of this cooperation agreement between bureaus is that banks can now access a bigger

database at lower cost. Once a bank files a request with either of two bureaus, the bureau in

question sends automatically a request to the other bureau. The role of the “Forum for

Leading International Financial Institutions” in providing a platform for this dialogue and

cooperation agreement should be highlighted.

The planned cooperation on data exchange between two leading bureaus is also quite

promising in terms of a more formalised approach of cooperation in the future. Looking

ahead, despite being in competition with each other, it might be very beneficial for private

credit bureaus in Ukraine to found an industry association, plans which are already under

discussion. This would give the bureaus the opportunity to represent the interests of its

members better during policy discussions, to improve cooperation among them, to inform

them on important matters and to reach a wider public audience. Many problems that we

identified in this report, especially regarding information submission and sharing may be

approached and eventually solved in the context of such a new institution.

20

2) Draft Law #10292 "On changes to legislative acts to improve activities of credit bureaus”

The Draft Law was registered in Parliament on 30 March 2012 and includes a number of

points meant to improve the operations of credit bureaus. In the following we concentrate on

a central feature of this draft, the creation of a central index of credit histories stored in

different private credit bureaus.

This central index follows the experience of Russia, which has a rather fragmented credit

information landscape. Currently, there are 33 private bureaus licensed, after more than 100

initially. The Central Bank of Russia keeps a central index of credit histories, where is

recorded in which particular bureau(s) credit histories of data subjects are stored17. This

index performs the function of a single information centre, informing banks in what

particular bureau they can find credit history information about a subject.

In Ukraine, the situation is not exactly comparable to Russia, as only a much smaller number

of bureaus exist. Among them, there are only about 3 established bureaus, which can be

considered “standard” bureaus. The benefit of using such an index appears therefore more

limited, in our view.

Recommendation 6: As in every competitive market with several private bureaus, data

fragmentation is an issue in Ukraine, and needs to be tackled. The recently announced

voluntary cooperation mechanism “One point of access” is a step in the right direction,

and should be further developed. In the future, the creation of an industry association of

credit bureaus might be the right forum for extending such activities. Establishing a

central index of credit histories under public administration may also help to improve data

fragmentation, even though the benefits are somewhat less clear.

5. Consumer Protection Issues

5.1. Privacy Data Protection

All around the globe, credit bureaus need to comply in their work with various laws and

regulations regarding the protection of sensitive personal data. While in practice the concrete

form can differ significantly from country to country, the general respect of the private and

confidential nature of such data is undisputed. Any improvement in information sharing in

terms of full and comprehensive reporting must be seen in combination with the

development of adequate data protection systems, which give the data subjects wide-ranging

rights to access, dispute and correct their stored data (Asian Bankers’ Association, 2008).

Thus, effective information sharing must be continuously balanced with protecting the

privacy of the individual (IFC, 2006).

17 It is important to note that this index only informs about the existence of credit information stored in

a particular bureau, but not the information itself. In a second step, banks need to address the bureaus for the credit history report.

21

In Ukraine, credit bureaus have to comply with requirements of the relatively new data

protection law18, which entered into force on 01 January 2011. This means in practice that

they have to register their database in a state register, inform anyone if they store his

personal data in their database and provide the person with her/his data contained in the

database. A new and material change in the law says that bureaus must now ensure that any

personal data they obtain from external sources other than banks and other lenders is

gathered in full accordance with the law. This means that that the consent of the subject has

been given.

The business model of “standard” credit bureaus is in general not impacted by the new data

protection law. However, the law is still in the initial stage of implementation. A number of

the provisions of the law is vague and may be interpreted ambiguously. This may create

previously unanticipated issues for credit bureaus but data protection requirements by the

credit bureau law and licensing requirements for credit bureaus should be sufficient to

satisfy the new legal requirements. The supervisor must ensure that credit bureaus obtain

information only from legal sources, don’t use illegal sources, and don’t leak gathered

information to other parties. Inquiries to credit bureaus must be restricted to only authorized

parties, and for permissible purposes. Due to on-going concerns in the sector that a number

of officially licensed “non-standard” bureaus use such illegal information, the main problem

as of now seems the strict implementation and enforcement of the norms of the law.

Recommendation 7: The new data protection law in Ukraine is somewhat vague, but if

implemented correctly provides sufficient privacy protection and seems balanced between

privacy and business efficiency objectives. However, the full enforcement of the norms

foreseen in the law by the responsible state authorities will be the key issue.

5.2. Credit Collection Agencies

Credit collectors are individuals or institutions (e.g. collection agencies) that regularly collect

debts owed to other parties like banks. Especially in Ukraine after the crisis, with its huge

increase in non-performing loans (especially among consumer loans), the activities of such

agencies have become more prominent.

In Ukraine, the current legal framework prevents such credit collection agencies from legally

accessing credit histories. While the civil code allows the transfer of the right to collect debt to

third parties, the credit bureau law does not take this into account. A related problem is that

no information from credit collection agencies activities feeds back into the system. In case

the debt is eventually settled, this would be vital information for the credit history of the

subject in question.

The Draft Law #10292 mentioned above allows anyone with the right to claim the debt access

to credit history. Thus, also credit collectors can now get access to credit bureaus’ databases.

However, it must be noted that the collection business in Ukraine is still not appropriately

licensed, regulated and supervised. A special law regulating the activities of such agencies is

18 Law of Ukraine No. 2297-VI “On Protection of Personal Data”, from 01 June 2010. The Law is based on the “Council of Europe Convention for the Protection of Individuals with regard to Automatic Processing of Personal Data”, which was ratified by Ukraine in 2010.

22

missing. This is why a number of stakeholders are skeptical of the idea to let collection

agencies access credit histories stored in bureaus’ databases. Such a step could be taken once

the collection industry is properly regulated and supervised.

Recommendation 8: The access of credit collection agencies to credit histories should be

granted only after the industry is fully regulated and under strong supervision. Otherwise,

this may damage the credibility of the whole the credit reporting system.

23

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